One Year on, Raghuram Rajan Relaxed About Capital Flows—For Now

Raghuram Rajan, governor of the Reserve Bank of India, marked a year in office 4 Sept. 2014

Bloomberg News

Reserve Bank of India chief, Raghuram Rajan, has made a name in global economic policy circles for his broadsides against advanced economies’ central banks and the spillover effect of their extreme stimulus policies on emerging markets. The gist of his complaint: smaller economies like his get unfairly buffeted by sharp shifts of capital flows triggered by the expansion and contraction of unconventional monetary policies adopted by the U.S. Federal Reserve and others.

Now, Mr. Rajan seems more relaxed about the state of global monetary policy, at least for the moment, arguing that as the improving U.S. economy heads in a different direction from struggling Europe and Japan, that will tend to smooth out global gyrations, and give India and others more flexibility to pursue their own monetary policies.

“The differentiation in policy is good,” he said in an interview with The Wall Street Journal.

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When he first took office a year ago, Mr. Rajan faced an immediate crisis, as the prospect of Fed “tapering”—winding down its bond-buying stimulus program—triggered a sharp outflow of capital from India and other emerging markets. That forced the Reserve Bank of India to raise interest rates to stanch the bleeding, even as economic growth slowed.

In April, Mr. Rajan gave a speech at the Brookings Institution in Washington, D.C., insisting on some kind of global coordination mechanism to help protect emerging economies from the actions of the world’s main central banks. “The current non-system in international monetary policy is, in my view, a substantial risk,” he said. “A first step to prescribing the right medicine is to recognize the cause of the sickness. Extreme monetary easing, in my view, is more cause than medicine.”

But now, as the European Central Bank seems to be heading toward just such extreme monetary easing, Mr. Rajan is more relaxed. In fact, he thinks it’s a good thing, for Europe, and for the global economy.

“As strong economies like the U.S. and the U.K. start going back to more normal monetary settings, weaker economies will depreciate their currencies, and will get some boost to growth from exports,” Mr. Rajan said in the Journal interview. “That’s really the advantage when policies get differentiated.”

And that doesn’t just help Europe. It helps policy makers in India as well. Many developing countries use dollars and euros to trade on global markets. As a result, their central banks may have to follow Fed and ECB monetary moves. That’s because, when the Fed raises rates, for example, they have little choice but follow, or face a sharp capital outflow as investors suddenly see higher returns in higher-rate economies.

But with policies in major advanced economies on diverging paths, countries like India could get more sway in their interest-rate decisions.

Indeed, many economists now see that India has gained more freedom to chart its own course, less chained to the Fed, thanks in part to Mr. Rajan’s successful steering of last year’s minicrisis. Even as the Fed continues to wind down its bond-buying and heads toward likely rate increases next year, the RBI seems to have freedom to keep rates on hold, or even to cut.

At Merrill Lynch, analysts said in a recent note that RBI and Fed monetary policy are no longer “synchronous.” UBS economists see the RBI cutting rates by two percentage points in less than two years, even if the U.S. raises rates.

Still, Mr. Rajan remains critical of the process of setting global monetary policy. As he has said in the past, and as he repeats often, developing economies are just bystanders, and the breather he sees for India due to current global economic circumstances is just a lucky coincidence.

“India doesn’t have a big role in this game,” Mr. Rajan said. “We experience the consequences but we’re really not players there.”

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